The global credit crisis and Indian Rupee!

[yasirdxb]

Although it is unlikely the crisis in the U.S financial sector will send India in to a tailspin, there are still some vulnerabilities. The banking sector in India is of course fundamentally sound. However there are chances for these firms holding a chunk of the so called toxic mortgage related securities. The securities -collateralised debt obligations, collateralised loan obligations and structured investment vehicles -had fallen steeply in value as a result of the U.S sub-prime mortgage crisis, triggering hefty write downs.

According to Morgan Stanley, slowing capital inflows in to emerging markets because of risk aversion will hit India the most. India has reported shortfalls in its trade account every month since April 2002.the deficit widened to a record $10.8 billion in July.

Foreign portfolio inflows accounted for 70 percent of the increase in total inflows in to India between 2006 and 2007.global funds bought a record $19.5 billion of Indian stocks and bonds in 2007, where they sold a net $6.7 billion in 2008 so far.

The ripple effects of the financial collapse are going to affect India as well. A number of investment banks have a lot of exposure in realty companies such as DLF and Unitech. The financial world is also much more interrelated because of the global banking relations. Thats why I suspect there would be a few causalities to the credit crisis in India also. The property asset bubble backed by the credit growth is another concern.

Tourism is another sector going to get a blow. Following the path of U.S, Briton and the Euro zones economic conditions are getting worse. 'Cutback' is the word we hears everywhere. Business travel, which has propped up the hotel industry amid a dip in demand from leisure travellers now looks ready to weaken.

No matter what the outcome of the bailout package is, India is going to see a slower economic growth and lesser foreign inflows for six to nine months. The rupee is going to hit 50 before finding any major support. That means below 11000 levels for Sensex.

Yasir.

 

[yasirdxb]

update 1

Although India has suffered relatively little direct effect from toxic American mortgage backed securities, a global downturn is proving a drag on exports. Slumping demand from the U.S and Euro zone is going to affect corporate earnings and leading to higher unemployment. With lower exports on the horizon, India is going to try to bolster domestic demand. We have a very big and active domestic market. So the global slowdown in growth is not going to affect us at large if the government ensures liquidity and credit facility by actions like cutting the key interest rates. This will ease the pressure on companies and individuals who are suffering from high interest rates. But the RBI probably fears that reducing interest rates at this time will lead to higher inflation, which they are not comfortable with. Inflation is already at record levels.

Once the financial turmoil settles down and the western economies turns to the recovery path, the IT sector would be the one who benefits mostly. I think the IT sector will be the new leaders of the next bull market in India. I just dont know when it is going to fire up exactly. For the time being investing in companies concentrating in the domestic market would be wise.
Even though the Sensex have fallen to the oversold territory, dont expect a V shape recovery in the near future. A significant rally is unlikely to be sustainable as long as fear continues to rule the markets. At some point the fear shown in the stock market will begin to be replaced by rationality and investors will wake up and realise that hundreds of wonderful companies have been dumped overboard. Over the long term, I am optimistic.

Yasir.

 

[yasirdxb]

Much of the capital flight from India has been simple risk aversion. But part is fear of being trapped. Central banks around the globe including RBI have been taken many measures to calm the markets. It is necessary to give them time to take effect. But it is difficult to imagine that things are going to improve dramatically any time soon. Clearly there is room for further decline on all international markets. Even if the markets find a support at current levels, the Indian equity market isn't going to be attractive for most investors. There are many other markets that offer a better risk/reward ratio. CLSA estimates half of the wealth of India is tied to property, making the country highly susceptible to a sharp break in economic growth. I strongly suspect there is a bubble waiting to burst in the property sector. When we see job losses and rising unemployment, this does not just affect those who lost their job. Wages grow more slowly when there is higher unemployment, so the downturn will be affecting most working families. With the pace of layoffs picking up, the cycle becomes a vicious one, pressuring consumer spending and hurting home values.

May bemay be the market is probably close to a low. But that alone is not a good reason to invest in any market. We want to see strong fundamentals along with favorable technical reading. Then there is the market sentiment, which is very important to keep an eye on. There is one market expert in my native place 'kerala', he appears in the T.V every time the Sensex records a new low and urges the public that its the END of the bear market and this is the TIME to invest and there is nothing wrong FUNDAMENTALLY. Even though his last prediction ( Sensex not falling below 10,000)went wrong again, I hope he is right next time.

May bemay be India is fundamentally strong and the chaos happening in the Indian market is causing by unjustified fear. May be this is the end of the bear market. But is that alone a good reason to invest in stock market? Ends of a bear market dont necessarily indicate a start of a bull market. When Japanese property bubble busted in late 1988, the Nikkei was trading just below 40,000. By 1992 the stock market was under 15,000. Many experts argued that it was the END and that is the TIME. Now almost 20 years has passed since then. The Nikkei is trading below 10,000 now!

Having said that, Equity markets worldwide have fallen so far and so quick in a short time span and some investors are beginning to scent good value in them. Fundamentals are relatively solid in India. Troubled property developers in India could pursue mergers and acquisitions as banks become choosier about which projects they finance during the global credit crisis. With tightening credit, most developers are going to suffer and they will have to revisit the basic fundamentals of the projects. The so called Libor rates for one month loans in dollars are sliding meanwhile yields on three month US treasury bills rose to new highs. That suggested that some investors have stopped hoarding safe haven instruments and are moving money into higher risk instruments. However any considerable FII inflows to India are still a distant chance for some time.

Of course there is a rally due in our market. Because we are massively oversold. But any significant rally would be a bear market rally, meaning that the gains would not herald a return to long term upward trends. The suggestions of the so called Gurus to buy equities again are entirely based on value after massive losses, rather than any new optimism for economic recovery.
There have been some positive surprises in some companies earnings results. However the key would be to look at what the companies are saying about performance in 2009. While confidence in the financial sector is on the mend, the liquidity injections may prevent inflation from falling. Those monies are going to show up somewhere in the economy! The Indian rupee has declined 20% this year, the worst performer in Asia after South Koreas won. Now it is flirting with 50 per Dollar which is my target. Actually it now seems falling below that level. However I have squared my sensex shorts as the double bottom below 10000 level holds for now. I am bullish for medium term and I expect a run up to 13000 levels.

Yasir.

 

[yasirdxb]

A financial crisis that started with intense pressure on vulnurable banks has now switched to vulnurable countries. Earlier this month the IMF published forecasts showing that while advanced economies would show no growth overall next year, emerging market countries would expand by more than 6 percent.

Money market rates fell last week in a sign that the programmes of the central banks around the globe and liquidity injections are easing the recent freeze in short term lending. Back in U.S, hopefully the housing market has found a base as the September's existing home sales figures increased by 5.5%, the biggest gain since July 2003. the number of foreclosure notices for the same month came at 81,312, easing down from the record high in August. In parallel, the U.S administration declared that it is preparing a 40 billion US dollar proposal to help curbing housing foreclosures.

It is the recent slide in the rupee that stopped the central bank from further loosening monetary policy as it may increase the risk of capital flight. What matters now is the flow of capital, rather than stocks and fundamentals and flows are unidirectional as everyone is selling. In situations like this markets are too wound up in the panic to pay any attention to changing fundamentals. A lot of people are going to keep selling just because that has been the thing to do.

A major reason for the recent horrific market action is redemption pressures on the hedge funds from panic stricken investors. But if you sell in to this market, you run a greater risk of being the last seller. Deleveraging is crucial to restoring the long term stability and health of the financial system, but it is the speed and severity with which it is happening that is fueling investor panic. I think we are going to relearn what financial discipline is all about!

Yasir.

 

[yasirdxb]

IMO The global crisis can be averted to a great extent as long as economies like ours, China etc, keep developing at a steady rate. After all the reins of world economy will eventually be in the hands of such emerging economies.

Nice essay.

Jeff,

The problem is that the emerging countries cannot keep the economic growth at this rate since most of the growth comes from the exporting sectors. china has already affected and unemployement is soaring. we may say that india is growing at a rate of more than 7 percent and it is better than most if not all of the developed countries. but considering the size of population, India has to grow atleast at this rate just to accomodate the labour force. a growth rate below 6 percent is enough to spell trouble to the labour market. anything les than 6 percent the economy cannot creat enough jobs to keep up with the mass of humanity.

India has pinned its hopes on domestic demand filling in for sagging exports.that will be hard to achieve if the economy weakens further.thats why the government try to deliver all kind of stimulus measures, even in the face of inflationary risks.

In India, the developers are borrowing to build shopping malls and luxuary apartments, not factories. India will pay for not using the easy credit to boost productivity and encourage exports.

Yasir.

 

[yasirdxb]

China has approved a 4 trillion yuan government spending package to boost domestic demand and help the world's fourth largest economy ride out the global credit crisis. Peoples bank of china has already relaxed the monetary policy. The latest investments would be targeted at roads, railways and airports across china. Money would also be poured in to affordable housing, rural infrastructure, the power grid, environmental protection, social welfare and technical innovations, xinhua news agency says. All else being equal, China's stimulus package should be sufficient to absorb the newly unemployed and keep growth for the time being. But we cant count on it saving us also.

China can afford to spend freely since it runs a budget surplus in the tune of $170bn for the first half of the year. The domestic treasury debt is just 16 percent of GDP. They are only second to Japan when it comes to foreign reserves. India has reported shortfalls in its trade account every month since April 2002.

India, china, korea all have huge foreign reserves, often in US treasury bonds since it is considered the safest form of insurance. But for India to tie up most of its capital abroad is ruinously expensive. This capital should be invested in the country's own development. Capital and financial flows to India are going to be restricted and more expensive with high current account deficit and large external funding needs most exposed. We will have to find our own way out of this hole.

The worst period of the great depression occurred between the election of FDR in November 1932 and his inauguration in march 1933. that was when the largest number of American banks had to close. So I think the world has to wait at least until Obama gets the full authority for any solid actions. There is no reason to think we have yet reached the bottom of this crisis. But I think we can say that we are in the process of bottoming out.

Yasir.

 

[yasirdxb]

Everyone in the market is now convinced that deflation is the chief enemy. Falling prices and growth, as suffered by the world in the 1930's and by Japan in the 1990s would be horrific. Rate cuts are the obvious measure to fight deflation. That stimulates economy by making money cheaper. Thats what is the central banks around the world is trying to do now. But with the banking system in a freeze, lower rates do not translate in to cheaper money for consumers and businesses. Printing more money is another option. The problem is that printing money and cutting rates are directly inflationary. If a global deflationary recession is averted it will be followed by resurgence of inflation. However during a recession, inflation is less of a concern.

The IMF has found recessions preceded by a financial crisis tend to be deeper and longer than others and they tend to be worse again if the crisis is in banking, rather than in equities and foreign exchange. Unfortunately the current downturn certainly fits those criteria.

So called market experts have already called a bottom. All of them are based broadly on the same thinking. Stocks are cheap by historical standards and all the bad is known and the dismal economic outlook is discounted. May be they are correct this time. May be the violent swings in recent weeks are part of the markets ongoing "bottoming" process, in which the market retests the recent lows. I expect the market to remain volatile as evidenced by past recoveries from a bear market. After all, equities have in the past started to recover when the economy is on the floor and many months before there has been any sign of an upturn.

As I noted earlier, it is my strong belief that the leaders of the next Bull Run in the Indian market would be the I.T companies. I am glad that I got company now. Credit Suisse has raised rating of Wipro and Tata consultancy from underperform to outperform, while Infosys stock rating is raised to outperform from neutral.

Yasir.